With the exception of assumed mortgage loans in 2008 on 15 of its hotel properties, substantially all of the purchases were funded with proceeds of the Company’s best-efforts offering of Units, which was completed in April 2008. The Company leases all of its hotels to its wholly-owned taxable REIT subsidiaries under hotel lease agreements. The Company also used the proceeds of its offering to pay $19.0 million, representing 2% of the gross purchase price for these hotels, as a commission to Apple Suites Realty Group, Inc. (“ASRG”), 100% owned by Glade M. Knight, the Company’s Chairman and Chief Executive Officer. No hotels have been purchased since December 2008, and there are no outstanding purchase contracts for additional hotels as of June 30, 2010.
Of the Company’s 51 hotels owned at June 30, 2010, six were purchased in 2007 and 45 were purchased in 2008.
As of June 30, 2010, the Company owned 51 hotels with 5,908 rooms. The Company’s portfolio of hotels owned is unchanged since 2008. Hotel performance is impacted by many factors, including economic conditions in the United States, as well as each locality. During the past two years, the overall weakness in the U.S. economy has had a considerable negative impact on both consumer and business travel. As a result, lodging demand in most markets in the United States has declined. Although economic conditions appear to be stabilizing, and in some markets improving over 2009 results, the Company expects demand for the industry as a whole to continue to be below pre-recession levels until general economic conditions improve. The Company does anticipate moderate revenue and income improvements as compared to 2009 due to the significant number of renovations (12) completed in 2009 and the significant number of newly opened properties acquired by the Company in 2008 (9) which were in a ramp up stage in 2009. The Company’s hotels have shown results consistent with industry and brand averages for the period of ownership.
For the six months ended June 30, 2010 and 2009, the Company had total revenue of $88.7 million and $82.5 million. Revenue for the New York hotel was $8.8 million or 10% of total revenue for the six months of 2010 and $5.0 million or 6% of total revenue for the six months of 2009. For the six months ended June 30, 2010, the hotels achieved combined average occupancy of approximately 70%, ADR of $109 and RevPAR of $77. The New York hotel had average occupancy of 86%, ADR of $238 and RevPAR of $205. For the six months ended June 30, 2009, the hotels achieved combined average occupancy of approximately 65%, ADR of $110 and RevPAR of $71. For the same period, the New York hotel had average occupancy of 61%, ADR of $170 and RevPAR of $105.
As reflected in the Company’s occupancy increase (the Company has seen year over year occupancy improvement every month since November 2009), the industry is beginning to realize an increase in demand as compared to 2009. The increase is a result of reduced room rates and the sense that the overall economy is stabilizing, generating more business and leisure travelers. While ADR still trails pre-recession levels, it has stabilized as compared to 2009. As a result, the Company’s RevPAR has increased 8% year to date as compared to the same period in 2009. The Company anticipates similar continued RevPAR improvement throughout the remainder of 2010.
While the revenue rates earned by the Company are consistent with industry and brand averages, the Company continues to focus on improving market share. The Company’s properties overall lead their respective markets with an Average RevPAR Index (a comparison of a property’s RevPAR to the market average) of 132 year-to-date, a 4% increase from 2009 for comparable properties.
During the first half of 2009, the Company was in the process of completing its conversion of the New York hotel from an unbranded hotel to a Renaissance hotel. Consequently, the hotel had an average of 32 rooms out of service each night for the first half of 2009 and experienced other disruptions to its common areas. As a result of the conversion effort and declines in economic conditions, revenue at the hotel was unusually low for the first half of 2009. The Company completed the conversion to a Renaissance in late April 2009. The RevPAR Index for the New York hotel was 115 for the six months ending June 30, 2010, an increase of 75% from 66 for the first six months of 2009. Although the hotel’s revenue has increased 77% in the first 6 months of 2010 as compared to the same period in 2009, the Company believes there continues to be opportunity for market penetration and continues to work with Marriott management to increase the RevPAR Index for the New York hotel.
Expenses
For the three months ended June 30, 2010, hotel direct expenses of the Company’s hotels totaled $28.0 million or 57% of total revenue (the New York hotel had direct expenses of $2.7 million or 56% of its total revenue for the quarter) and for the three months ended June 30, 2009 direct expenses were $26.8 million or 59% of total revenue (the New York hotel had direct expenses of $2.3 million or 72% of its total revenue for the quarter). For the six months ended June 30, 2010 and 2009, hotel direct expenses of the Company’s hotels totaled $52.8 million or 60% of total revenue (the New York hotel had direct expenses of $5.2 million or 59% of its total revenue for the quarter) and $51.1 million or 62% of total revenue (the New York hotel had direct expenses of $4.0 million or 80% of its total revenue for the quarter). Hotel direct expenses consist of operating expense, hotel administrative expense, sales and marketing expense, utilities expense, repair and maintenance expense, franchise fees and management fees. Operating expenses in 2009 were negatively impacted due to the significant number of renovations and the ramp up of newly opened hotels in late 2008.
The Company continues its efforts to control costs, however, certain operating costs such as management costs, certain utility costs and minimum supply and maintenance costs are relatively fixed in nature, and cannot be curtailed or eliminated. The Company has been successful in reducing certain labor costs, food and supply costs and utility costs by continually monitoring and sharing utilization data across its hotels and management companies.
Taxes, insurance, and other expense for the three months ended June 30, 2010 and 2009 totaled $2.7 million and $2.6 million, or 6% of total revenues (of which approximately $208 thousand and $77 thousand related to the New York hotel). For the six months ended June 30, 2010 and 2009, taxes, insurance, and other expenses were $5.3 million and $5.0 million, or 6% of total revenues (of which approximately $345 thousand and $210 thousand related to the New York hotel).
Land lease expense was $1.6 million for both the three months ended June 30, 2010 and June 30, 2009 and was $3.2 million for the six month periods ended June 30, 2010 and 2009. This expense represents the expense incurred by the Company to lease land for five hotel properties. Land lease expense for the New York hotel was $1.5 million for each second quarter of 2010 and 2009 and was $2.9 million for the six months ended June 30, 2010 and 2009.
General and administrative expense for the three months ended June 30, 2010 and 2009 was $1.5 million and $1.3 million. For the six months ended June 30, 2010 and 2009, general and administrative expense was $2.7 million and $2.4 million. The principal components of general and administrative expense are advisory fees, legal fees, accounting fees, reporting expense, and the Company’s share of loss from its investment in Apple Air Holding LLC.
Depreciation expense was $8.7 million for the second quarter of 2010 and $8.1 million for the second quarter of 2009. For the six months ended June 30, 2010 and 2009, depreciation expense was $17.4 million and $16.0 million. These expenses include $1.6 million and $1.4 million for the New York hotel
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for the quarterly periods and $3.2 million and $2.7 million for the six month periods ended June 30, 2010 and 2009. Depreciation expense represents depreciation expense of the Company’s hotel buildings and related improvements, and associated furniture, fixtures and equipment, for the respective periods owned. The increase is a result of capital improvements made by the Company in 2009 of approximately $25 million to complete 12 renovations.
In the first quarter of 2010, the Company sold its equity securities in a publicly traded real estate investment trust, resulting in realized gains and other investment income of $3.0 million. For the same period in 2009, the Company had investment income of $12 thousand.
Interest expense for the second quarter and six months ended June 30, 2010 was $2.3 million and $4.4 million. Interest expense for both periods includes interest expense on 15 mortgages assumed in 2008 and the Company’s line of credit offset by capitalized interest of $101 thousand in the first quarter of 2010 related to the renovation of 2 hotels. Interest expense for the same periods in 2009 was $1.9 million and $3.4 million, offset by capitalized interest of $376 thousand for the three months of 2009 related to three hotels under renovation and $947 thousand for the six month period in 2009, related to the renovation of eight hotel properties.
Liquidity and Capital Resources
In November 2008, the Company entered into a $75.0 million revolving line of credit which expires in November 2010. The line of credit was obtained to meet short-term cash needs as the Company planned on completing a significant number of hotel renovations, and newly opened properties have a period of ramp up to normal operating status. Through June 30, 2010, substantially all of the planned renovation work was completed. With the availability of this line of credit, the Company maintains little cash on hand, accessing the line as necessary. As a result, cash on hand was $0 at June 30, 2010. The outstanding balance on the line of credit was $70.8 million at June 30, 2010 and its interest rate was 2.1%. The Company anticipates that cash flow from operations and the revolving line of credit will be adequate to meet its liquidity requirements, including required distributions to shareholders, capital expenditures and debt service. The Company is pursuing extending its existing debt that is due in 2010 and additional financing in 2010 so that it can make distributions in excess of required amounts to maintain its REIT status. The Company intends to maintain a relatively stable dividend rate instead of raising and lowering the distribution rate with varying economic cycles. With the depressed financial results of the Company and the lodging industry, the Company will attempt to utilize additional financing to achieve this objective. Although the Company has relatively low levels of debt, there can be no assurances it will be successful with this strategy and may need to reduce its distributions to required levels.
To maintain its REIT status the Company is required to distribute at least 90% of its ordinary income. Distributions in the first six months of 2010 totaled $36.1 million and were paid monthly at a rate of $0.064167 per common share. For the same six month period, the Company’s cash generated from operations was approximately $16.2 million. This shortfall includes a return of capital and was funded primarily by additional borrowings under the Company’s line of credit facility. The Company intends to continue paying distributions on a monthly basis. However, since there can be no assurance of the ability of the Company’s properties to provide income at this level, there can be no assurance as to the classification or duration of distributions at the current monthly rate. In consideration of the weakness in economic conditions throughout the United States, the Board of Directors monitors the Company’s distribution rate relative to the performance of the hotels on an ongoing basis and may make adjustments to the distribution rate as determined to be prudent in relation to other cash requirements of the Company. In April 2009, the Board of Directors approved a reduction in the Company’s annual distribution rate from $0.88 to $0.77 per common share. The reduction of the dividend was effective beginning with the May 15, 2009 distribution.
The Company has on-going capital commitments to fund its capital improvements. The Company is required, under all of the hotel management agreements, to make available, for the repair, replacement, refurbishing of furniture, fixtures, and equipment, a percentage of gross revenues provided that such amount may be used for the Company’s capital expenditures with respect to the hotels. As of June 30,
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2010, the Company held $8.8 million in reserve for capital expenditures. Total capital expenditures in the first six months of 2010 were $4.5 million. Total capital expenditures for 2010 are anticipated to be approximately $10-11 million. The Company completed 12 renovations throughout 2009. In 2010 the Company anticipates the completion of three renovations, thus substantially reducing capital expenditures as compared to 2009.
In the second quarter of 2008, the Company instituted a Dividend Reinvestment Plan for its shareholders. The plan provides a convenient and cost effective way to increase shareholder investment in the Company by reinvesting dividends to purchase additional Units of the Company. The uses of the proceeds from this plan may include purchasing Units under the Company’s Unit Redemption Program, enhancing properties, satisfying financing obligations and other expenses, increasing working capital, funding various corporate operations, and acquiring hotels. The Company has registered 10 million Units for potential issuance under the plan. During the first six months of 2010, approximately 1.2 million Units were issued under the plan representing approximately $13.1 million. For the six months ended June 30, 2009, approximately 1.3 million Units were issued under the plan representing approximately $13.9 million. Since inception of the plan through June 30, 2010, the Company has issued approximately 5.1 million Units representing approximately $55.9 million.
The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any 12-month period will be three percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price for redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. During the six months ended June 30, 2010, the Company redeemed approximately 529 thousand Units in the amount of $5.5 million under the program. For the first six months of 2009, the Company redeemed approximately 696 thousand Units in the amount of $7.1 million. Since inception of the program through June 30, 2010, the Company has redeemed approximately 1.9 million Units representing approximately $19.7 million.
Related Party Transactions
The Company has significant transactions with related parties. These transactions cannot be construed to be arm’s length, and the results of the Company’s operations may be different if these transactions were conducted with non-related parties.
The Company has a contract with Apple Suites Realty Group (“ASRG”), to provide brokerage services for the acquisition and disposition of the Company’s real estate assets. In accordance with the contract, ASRG is paid a fee of 2% of the gross purchase price of any acquisitions or gross sale price of any dispositions of real estate investments, subject to certain conditions. As of June 30, 2010 payments to ASRG for services under the terms of this contract have totaled $19.0 million since inception, which were capitalized as a part of the purchase price of the hotels. No brokerage services were provided by ASRG in the first six months of 2010 or in 2009.
The Company is party to an advisory agreement with A8A, pursuant to which A8A provides management services to the Company. An annual fee ranging from 0.1% to 0.25% of total equity proceeds received by the Company, in addition to certain reimbursable expenses, are payable for these services. A8A utilizes Apple REIT Six, Inc. to provide these services. Total expenses related to this agreement totaled $1.6 million in the first six months of 2010 and $1.4 million for the same period in 2009. Of these total expenses, $0.5 million were fees paid to A8A for each of the six months ended June 30, 2010 and 2009 and $1.1 million and $0.9 million were expenses reimbursed by A8A to Apple REIT Six, Inc. for the six months ended June 30, 2010 and 2009. These expenses are recorded in General and Administrative expense.
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ASRG and A8A are 100% owned by Glade M. Knight, Chairman and Chief Executive Officer of the Company. Mr. Knight is also Chairman and Chief Executive Officer of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc. Members of the Company’s Board of Directors are also on the boards of Apple REIT Six, Inc., Apple REIT Seven, Inc. and Apple REIT Nine, Inc.
Subsequent Events
In July 2010, the Company declared and paid approximately $6.1 million in distributions to its common shareholders, or $0.064167 per outstanding common share. Under the Company’s Dividend Reinvestment Plan, $2.2 million were reinvested, resulting in the issuance of approximately 198,000 Units.
In July 2010, the Company redeemed approximately 274,000 Units in the amount of $2.8 million under its Unit Redemption Program.
Impact of Inflation
Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation. Competitive pressures may, however, limit the operators’ ability to raise room rates. Currently the Company is not experiencing any material impact from inflation.
Business Interruption
Being in the real estate industry, the Company is exposed to natural disasters on both a local and national scale. Although management believes there is adequate insurance to cover this exposure, there can be no assurance that such events will not have a material adverse effect on the Company’s financial position or results of operations.
Seasonality
The hotel industry historically has been seasonal in nature. Generally, occupancy rates and hotel revenues are greater in the second and third quarters than in the first and fourth quarters. As a result, there may be quarterly fluctuations in results of operations. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, the Company expects to utilize cash on hand or available credit to make distributions.
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board issued a pronouncement (Accounting Standards Update No. 2009-17) which amends its guidance surrounding a company’s analysis to determine whether any of its variable interests constitute controlling financial interests in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics: (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. Additionally, an enterprise is required to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity’s economic performance. The new pronouncement also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and enhanced disclosure about an enterprise’s involvement with a variable interest entity. This pronouncement was adopted by the Company in the first quarter of 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
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Item 3.Quantitative and Qualitative Disclosures About Market Risk |
The Company does not engage in transactions in derivative financial instruments or derivative commodity instruments. As of June 30, 2010, the Company’s financial instruments were not exposed to significant market risk due to foreign currency exchange risk or commodity price risk. The Company will be exposed to interest rate risk due to possible changes in short term interest rates as it invests its cash or borrows on its line of credit and due to its variable interest rate mortgage on its Columbia, South Carolina hotel. The Company had an outstanding balance of $70.8 million on its $75 million line of credit at June 30, 2010, and to the extent it utilizes the line of credit, the Company will be exposed to changes in short-term interest rates. The outstanding balance of the Company’s variable rate mortgage was $11.0 million at June 30, 2010. Based on these outstanding balances at June 30, 2010, every 100 basis point change in interest rates will impact the Company’s annual net income by $0.8 million, all other factors remaining the same. The Company’s cash balance at June 30, 2010 was $0.
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Item 4.Controls and Procedures |
Senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective and that there have been no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Since that evaluation process was completed there have been no significant changes in internal controls or in other factors that could significantly affect these controls.
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PART II. OTHER INFORMATION
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Item 2.Unregistered Sales of Equity Securities and Use of Proceeds |
Unit Redemption Program
The Company has a Unit Redemption Program to provide limited interim liquidity to its shareholders who have held their Units for at least one year. Shareholders may request redemption of Units for a purchase price equal to 92% of the price paid per Unit if the Units have been owned for less than three years, or 100% of the price paid per Unit if the Units have been owned more than three years. The maximum number of Units that may be redeemed in any 12-month period will be three percent of the weighted average number of Units outstanding during the 12-month period immediately prior to the date of redemption. The Company reserves the right to change the purchase price for redemptions, reject any request for redemption, or otherwise amend the terms of, suspend, or terminate the Unit Redemption Program. The following is a summary of redemptions during the second quarter of 2010 (no redemption occurred in May and June 2010).
| | | | | | | | |
Issuer Purchases of Equity Securities |
|
| | (a) | | (b) | | (c) | | (d) |
Period | | Total Number
of Units
Purchased | | Average Price Paid
per Unit | | Total Number of
Units Purchased as
Part of Publicly
Announced Plans
or Programs | | Maximum Number
of Units that May
Yet Be Purchased
Under the Plans or
Programs |
| |
| |
| |
| |
|
April 2010 | | 312,864 | | $10.25 | | 1,905,043 | | (1) |
(1) The maximum number of Units that may be redeemed in any 12 month period is limited to three percent (3.0%) of the weighted average number of Units outstanding from the beginning of the 12 month period.
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| | |
Exhibit
Number | | Description of Documents |
| |
|
|
3.1 | | Articles of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| | |
3.2 | | Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.2 to amendment no. 1 to the registrant’s registration statement on Form S-11 (SEC File No. 333-140548) effective July 19, 2007) |
| | |
31.1 | | Certification of the Company’s Chief Executive Officer pursuant to Rule 13a – 14(a) and Rule 15d – 14(a) of the Securities Exchange Act, as amended (FILED HEREWITH). |
| | |
31.2 | | Certification of the Company’s Chief Financial Officer pursuant to Rule 13a – 14(a) and Rule 15d – 14(a) of the Securities Exchange Act, as amended (FILED HEREWITH). |
| | |
32.1 | | Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (FILED HEREWITH). |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Apple REIT Eight, Inc. | | |
| | | |
By: | /s/ GLADE M. KNIGHT | | Date: August 3, 2010 |
|
| | |
| Glade M. Knight, | | |
| Chairman of the Board, and | | |
| Chief Executive Officer | | |
| (Principal Executive Officer) | | |
| | | |
By: | /s/ BRYAN PEERY | | Date: August 3, 2010 |
|
| | |
| Bryan Peery, | | |
| Chief Financial Officer | | |
| (Principal Financial and Principal Accounting Officer) | | |
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